July 18, 2005
THE NEW NEW SENTIMENT SHUFFLE
The bond market today found more incentive to sell the benchmark 10-year Treasury Note. That includes fresh admonitions from Morgan Stanley's Richard Berner, the firm's chief U.S. economist, to "buy TIPS, sell bonds."
There's been a "remarkable turn in sentiment regarding the US economic outlook, one with significant consequences for fixed-income investors," Berner writes in a research note today. "Three months ago, investors were beginning to believe that soaring oil prices—unlike in the stagflationary 1970s—would both depress real growth and cap inflation."
But that's history, Berner relates. "Today, core inflation has slowed significantly but the economy appears poised to accelerate from a slightly-below trend pace in the spring quarter to one potentially above trend in the second half of 2005." That's at least half a buy signal, and strong enough to move minds.
Investors need to pay attention. Sentiment in the bond market is evolving faster than the thinking of a politician on the receiving end of a pile of new polling data. It was just last month that the yield on the 10 year fell to around 3.9%, inspiring some wags to proclaim that recession was just around the corner. But such thinking is so June. It's a new month, don't you know, and it's time to rethink, refresh, and (much to Wall Street's joy) trade again.
Informed or not, the bond market's current thinking seems to agree with Berner's view of the world. The yield on the 10-year inflation-indexed Treasury has climbed sharply this month and today approached 2.0%--that's a real yield of 2.0%, the highest since August 2004. "Following three years at depressed levels, real yields are finally starting to reflect the prospects for US growth…." he asserts.
Yields haven't quite soared as much in nominal land, but a more robust ascent can't yet be ruled out. Indeed, the nominal 10-year Treasury Note's yield moved higher again today, closing above 4.2% for the first session since early May. Stoking the fires of selling is the latest from the dismal scientists who're card-carrying members of the National Association of Business Economics. NABE this morning released they're assembled wisdom in the form of a survey, which expects "solid growth" in the economy.
“In the second quarter, demand and profit margins are both stable and strong by historical standards," Gene Huang, chief economist, FedEx Corp., says by way of the NABE release. "Hiring plans continue to improve. The growth of capital spending remains brisk with the expectation of further expansion ahead. There are continued signs of inflation, with a pickup in wage and salary growth and a rise in material costs and prices charged to customers."
But if the fixed-income set was alarmed by the NABE's findings, they may want to think twice before going off the deep end on this report alone, suggests Barry Ritholtz, chief investment strategist at the Maxim Group in New York. The economists polled by NABE have a less-than-stellar history as a collective in forecasting the future for growth, inflation, employment and capital spending, he opines today on his " blog The Big Picture.
Perhaps, although there are other reasons to sell Treasuries beyond perusing the latest NABE numbers. That includes the Fed itself, which seems inclined to stay the course when it comes to hiking interest rates. Or so the futures market suggests. The August Fed funds futures contract is priced in anticipation of another 25-basis-point hike when the FOMC meets again next month on the ninth. That would bring the Fed funds rate to 3.5%. Who knows? Rising short rates might very well induce something similar in long rates. But let's no go overboard, at least not yet.
Indeed, the debate in fixed-income circles has become a bit hotter, and a bit heavier of late, with bulls and bears squaring off against one another in ever more frantic pulses. For the moment, the bears seem to have the upper hand, although it's far from clear that the debate is over.
A test of whether the bonds or bulls have the stomach to go the distance may come on Wednesday, when the Maestro testifies to Congress on the state of the U.S. economy. "In a week with relatively little hard data, Mr. Greenspan's monetary policy testimony will be by far the most important event for investors," Ian Shepherdson, chief U.S. economist at High Frequency Economics, wrote in a research report, according to Reuters.
Of the sparse economics news otherwise scheduled for release in the coming days, the Conference Board's leading economics indicator promises to be a relative highlight for market influence this week after the Alan show concludes. If the trend in 2005 is any guide, the LEI for June will again post in negative territory, suggesting that the future path for the economy is a slowdown of some degree. Save for April's zero reading, every month through May has shown LEI in negative territory. Will the fashion hold true again? The bond bulls are hoping for no less as a weapon to beat back the bears' new-found momentum.
Then again, perhaps there will be no dramatic surprises either way, whether in testimony or data. But drama may nonetheless be needed to push the fixed-income set out of its sentiment see-saw of recent months. No matter, though, since if you're a trader a conclusion is required, even when none is obviously forthcoming. With that in mind, one practitioner of the dark art extends an effort at foresight, albeit one that's hedged. "Growth appears to be proceeding at a reasonable click and it will keep the Fed in the game,'' Stephen Miller, a fixed-income manager at Merrill Lynch Investment Managers in Sydney, tells Bloomberg News. "We've got a mild bearish disposition'' on Treasuries.
Miller's not alone in that thinking, as today's action suggests. Whether he'll still be in the majority of trading sentiment after Alan speaks is the question of the moment.
Posted by jp at July 18, 2005 8:01 PM
To be fair to the NABE Economists, the corporate executives who participate in the survey are the ones with the horrific track record at predicting their own spending and hiring behaviors.
What the Economists get wrong is actually believing what the CEOs/CFOs say (rather than watching what they actually do). . .
Posted by: Barry Ritholtz at July 19, 2005 6:17 AM